Last August John Deluca, developer of the Sentinel at Landmark in Alexandria, had 203 unsold condominiums in the 272-unit complex, interest payments of nearly $7,000 a day and no buyers in sight.
"We had the choice of going bankrupt or selling the units the best we could," he recalled. He solved his problem by calling a Boston corporation that matches high-income professionals in need of large tax write-offs with developers in need of sales.
The firm put together a group of investors who bought all 203 of his units, and Deluca became one of an increasing number of Washington area developers who, thanks to the provisions of the new tax law enacted last year, are successfully finding groups of investors to rescue them from the plight of carrying hundreds of unsold units.
Condominium sales, which were down by 50 percent in the Washington area earlier this year, are still slow, but the number of unsold units has dropped from 9,000 to 8,000 in the last 90 days largely because of sales to investors, according to G.V. (Mike) Brenneman, president of the Washington Board of Realtors.
Condominium projects, once envisioned as vertical communities of homeowners, have always attracted individual investors who purchased units to rent out, hoping for both tax benefits and later resale profits.
An estimated 25 to 33 percent of the 100,000 condominiums in the Washington area are now owned by these investors, Brenneman said.
Since January, another 1,000 to 2,000 condominium units have been bought up by groups of investors, according to both Brenneman and Robert Axelrod, vice president of The Investors Group, which specializes in pairing up condominium developers and investor groups.
Developers in this area and around the country started exploring sales to syndicates of doctors, lawyers and accountants who wanted rental properties, instead of individual buyers who would live in the units, because three years of high interest rates and high prices had virtually killed off sales in the once flourishing market.
They began asking themselves, "What the hell are we going to do with these damn units," said Brenneman, one of the area's leading condominium developers. He said he is exploring such a sale in one of his projects in Washington.
"It's only happening because the new tax law has had an enormous impact in this area and has made this possible," he said.
Investing in all kinds of rental property became more attractive last year after Congress changed the tax laws to allow investors to depreciate -- deduct from their federal income taxes -- the total cost of their buildings in 15 years instead of the previous schedule of 30 years. By cutting the depreciation time in half, Congress doubled the deductions available to investors each year.
IRS regulations allow an investor to deduct from his taxes as much as 12 percent of the cost of the condominiums in the first year instead of 6 to 7 percent. In the following year the deduction can be as much as 11 percent, with 9 percent the following year.
Investors with incomes in excess of $100,000 a year and a net worth of more than $250,000 can shelter $2 to $4 of income for every $1 invested, according to several real estate experts. These experts say persons with lower incomes or net worth are generally not involved in such deals because they do not have the resources to make the annual payments that are required.
"Syndications," as deals involving sales to groups of investors are called, are popular among condominium lenders, developers and the investors because they all either make money or at least stop losing it.
"I can't say lenders like it, but it's better than the project going into default" because developers can't pay the interest on their construction loans, said Robert Pickeral, vice president of real estate at Riggs Bank.
"If the units will not sell or are selling at a slow rate they developers will sell to a partnership and a combination of the proceeds from the sale plus the rental income will carry the project at a reasonable rate of return for the lender and the developer," he said.
But the deals have ramifications for individuals who bought units with the idea that they would be living in a community of largely owner-occupants, said attorney Benny Kass, who represents several condominium associations.
"I'm sympathetic to the poor developer who has no choice, but the poor homeowner who purchased thinking it would be a condominium is finding out it's just another apartment building," said Kass.
The syndication of condominium units is one of several devices used by developers and their lenders this year to spur sagging sales.
The developers have tried offering below-market mortgage interest rates and reducing their prices, but "the public has become blase about deep discounts," Brenneman said.
Garry and Scott Nordheimer, two of the area's most active condominium converters, are preparing to sell the last 100 units in their 900-unit Parkside condominium project in Bethesda to a group of investors.
Garry Nordheimer said their sales had not been affected by the downturn and that they had paid off their construction loan, but he and his brother decided to sell to a syndicate because "it's a quicker way."
The sale to an investor group will take about three to five weeks, he said, compared with six months or longer to find individual home buyers.
The Nordheimers have also placed full page newspaper ads to find individual investors to buy unsold condominium units in two of their other projects, Thomas Choice in Gaithersburg and Woodlake Towers in Falls Church.
At the same time, the company is offering to rent the empty units at discount rates, so they will be able to offer the investors units that already produce income.
The Washington area, like other metropolitan areas, is experiencing a higher than normal vacancy rate in apartments, because renters are choosing to share unsold single-family homes. But real estate experts say condominium units, although many are simply converted apartments, are somewhat easier to rentbecause they are either new or have been substantially remodeled.
Every syndication deal is different, but the way they generally work is through an agreement between a bank, a developer and an investors' group. The bank agrees to accept a delay in payment of its construction loan, usually due within a year or two. The investors then usually buy all the unsold units in a project at a price that includes repaying that construction loan over a period of five to seven years at a fixed interest rate.
Since the income from rented condominiums is usually not enough to pay the bank's note and other expenses such as condominium fees, the investors, usually 20 to 30 people per syndication, must pay up to $10,000 a year to make up the difference.
Each investor is allowed to deduct from his income taxes his share of all expenses, including those annual payments and depreciation on the amount of the project he owns.In addition to the tax deduction, investors generally hope to sell units at a substantial profit in five to seven years.
To make the deals even more attractive to investor groups, some banks have offered special incentives, such as charging a specified interest rate but agreeing to accept only a portion of it, with the remainder due whenever the condominiums are sold by the investors. Such an arrangement allows the investors to legally write off the entire specified amount of interest during the life of the deal even though the group is actually paying only a portion of it at the time, according to accountant David Reznick of Reznick, Fedder and Silverman.
"All of these sales to investors are still just a method of parking the inventory glut for several years, using the tax laws so that the deficits the difference between the rents and operating costs including the cost of the outstanding loan are covered" and hoping for an improved market in the future, Brenneman said.